Understanding Key Person Insurance

When a company is the beneficiary of a life insurance policy payout on a particular person's life, the person who died would have been considered as a key person with regards to the running of the company. The life insurance policy the company held on his or her life would have been considered as being key person insurance. This type of insurance has been introduced in more recent times as a way of compensating a company for the loss of key personnel so that the company doesn't suffer too much financially while the lost person is being replaced. It is more commonly used to cover the loss should the owner, partner or highly valued employee die in circumstances where the company was not prepared.

Larger companies would be likely to take out a life insurance cover over such people as a top executive, a principal shareholder, a top salesman or an employee who was of such importance that his or her loss could put the company at a financial disadvantage. Smaller businesses are more likely to take out the same type of cover to protect the business against any financial loss following the death of people who are crucial to the day to day operation of the company.

The type of person considered to be a key person to the successful running of a particular business depends a lot on the kind of business involved. In the case of many small businesses, it would most likely have been founded by one or two persons, usually the partners or owner. These people would have put a lot of time and effort into making sure the business succeeded. They would carry with them much information on the running of the business that would be hard to transfer to another person without them having some experience. If the owner, or one of the partners, were to suddenly die, taking this experience with them, it would take time to have them replaced. During this time the business would be at a financial disadvantage, and the loss would have to be recuperated in some way. Protecting a company from this loss can be achieved through key person life insurance.

Compensation for Loss of Expected Income

Good sales people are very hard to find and if a company was to lose the services of a key salesperson through an unexpected death, it could set the company back financially and leave it vulnerable to a competing company taking advantage of the situation. If key person insurance had been taken out on the life of the valuable salesperson, the company would be compensated for any loss of expected income while a new employee was settling in and going about selling new contracts.

There are many companies that rely on key personnel especially in the area of new technology. This is an area of constant change and it is not unusual to find an employee actually has more knowledge in this area of business that does the owners do themselves. If that salesperson was to suddenly die the business could well be at a financial disadvantage in not being able to continue until a suitable replacement was found.

In both these cases key person life insurance would be a very important tool for the businesses involved to invest in. Key person life insurance proceeds could be useful to a small business for the following reasons:

If the business has to close down because the key person could not be replaced, the insurance money could be used to close the business down in a proper manner by paying severance pay to the employees, to pay out all outstanding debts and distribute money owed to investors.

Pay all ongoing expenses until a suitable replacement is found.

Allow surviving partners to buy shares in the company from the family of the partner who has died.

In extreme cases the proceeds could be used to avoid bankruptcy of the business.

Lenders Sometimes Require Key Person Insurance

Many lenders who loan money to a business will require that the business take out key person life insurance on certain people involved with the company who they consider vital to the ongoing profitability of the business. When this is required as part of the loan conditions the company will be required to pay the premiums but the lender will be the beneficiary. This is made a requirement so that if the key person dies the lender will be assured of getting their money back. It is not unusual in these circumstances for the company itself to take out the cover on the person or persons beyond that required by the lender so that if the key persons were to die the company would receive compensation over and above that required by the lender.

If you are a sole trader and you have no employees there is no reason to consider key person life insurance. In these circumstances all you need to worry about is making sure you have sufficient personal life insurance so that should you die you don't leave a financial burden on those you leave behind.

This article was written by John from lifeinsurancefinder.com.au. Visit Life Insurance Finder to learn more about key person policy.


Financial Planning, Insurance