The Ultimate Guide to Key Man Insurance
Key Man Insurance is a life insurance policy suitable for all sizes of business including sole traders. It ensures that any key members of the team that are crucial to the success of the business have life insurance. Unlike a personal life insurance policy, key man insurance pays the money back into the business to help cover the loss of profits, pay off any debts, recruit new key members and either keep the business running or close down the company.
Insurance won’t be able to stop the death of a key member of staff, but it can provide the financial support to make dealing with it easier.
How does it work?
Key man insurance works differently depending on the type of your business and your role within it. Ultimately, it pays the money back into the business to help the business pay off debts, find a replacement, pay for recruitment and temporary cover and replace any loss of profits or goodwill.
If you are a director of a business or business owner, key man insurance is the perfect life insurance for you. It helps to pay the money back into the business if you were to die or become critically ill. What’s more, if the payout is for the purposes of the business, i.e. to cover training, loan repayments and loss of profits, you can run the insurance through as a business expense. This can help to offset against corporation tax and help to save you money.
If you’re a major shareholder, the policy works differently when it comes to tax. Instead of running the premium through the business as a business expense, the payout isn’t taxed in return. So, there will be more money left over for your family.
If you want to provide life insurance for a key member of the team that pays back into the business, key man insurance is the policy you’ll want. You can insure anyone who you think is crucial to your business profits and success. If you were to lose that key member, how much would it cost your business? This can include someone like a sales manager with years’ worth of client relationships built up, a software developer who runs and maintains all your systems, or any other key member of your team.
Key man insurance is also available for sole traders. There is no real distinction between the business and a sole trader. Therefore, when a sole proprietor passes away, the business normally closes. In this case, any debts, commercial mortgages and anything else falls into the estate and is normally passed to the family. All your business assets are normally sold off to cover your debts and close of all the business and anything remaining goes to the family. However, if you do not have enough funds to cover the debts, then your family could be left will the bill.
Key man insurance can be taken out by a sole trader. Although the premiums aren’t tax-efficient, the payout is not normally taxed. Therefore, your family will have more money to cover the business closure and keep what is in the estate to protect them financially.
Does it cover illness?
A key man insurance policy covers you when you are diagnosed with a terminal illness. This covers you if you were to pass away due to the illness within 12 months.
However, it doesn’t cover serious and critical illnesses such as heart disease, strokes and cancer.
If you would like to have a protection policy in place that covers you if you were to be off work due to a long-term serious illness, a critical illness policy can be taken out alongside your key man insurance or separately.
Critical illness is more likely to occur during your working life than death. Taking time off due to a serious illness can place a financial strain on the company and your finances. With critical illness, those costs are covered until you are well enough to return to work.
When I make a claim, what can the money be used for?
In the event of a key employee’s death or critical illness, a claim can be made to the provider. The agreed money is then paid back into the business or to the chosen beneficiaries. The business can then use the money to:
- Recruit and train new employees
- Keep the business running after the loss of important contacts and clients
- Meet any existing loan repayments or pay off loans and debts
- Protect against the loss of goodwill
- Help the business if they face difficulties raising finance for new developments
- Hire temporary personnel
- Hire or train someone with existing knowledge of the business process and systems
- Protect against any loss of profits during this time
- Pay any employees at the close of business
- Change names and details on legal documents
- Provide compensation for any loss of goods to customers
- Close down the business
Why is key man insurance important for my business?
For small businesses, sole traders and limited companies, there can be a huge financial impact when a key member of staff is lost. The business may suffer from issues securing investment, managing the business and keeping it running and profitable.
Without a protection policy in place, the death of a key employee or director can make a business vulnerable. Without leadership, employees may choose to go elsewhere. Similarly, customers may also choose to go to competitors. Sales could fall, new products could be delayed and a lack of confidence in the business can be felt by lenders and suppliers. If the key employee were to have signed for loans or overdrafts, then banks may call for these to be paid.
Key man insurance is needed if the business cannot replace or fulfil these commitments without the key person. If the absence is felt and impacts the business greatly, then this type of policy can maintain goodwill and keep the business running without the dangers of losing orders and profits.
Who is a key person?
Basically, a key employee is anyone whose absence would cause a detrimental effect on the efficient running of the business. Sometimes there may only be one, but there may be several key people.
Normally, a key person is directly responsible for a large portion of profits. However, they could also possess a unique skill or knowledge that is critical to the business operations. This can include director and CEO, key sales managers, project managers, web designers, marketing and lead generation, developers and IT professionals and engineers.
How much cover is needed?
Once you decide to insure a key employee, you’ll need to understand their contribution towards gross profits. It may be based on the investments and sales they bring in or projected returns. You may also want to consider recruitment costs and training too in the cover amount.
It’s important not to underestimate the risk, but also not to get more coverage than you need. Otherwise, you’ll be paying more unnecessarily. Sometimes you can multiply the profits they make the business by 2 or 5. Alternatively, you can multiply their salary too, but each person must be valued on their own contributions.
How long do I need to take key man insurance out for?
Key man insurance is typically a term life insurance policy. Therefore, it will come to an end at some point. If the person insured does not pass away within the term, the life insurance cover will run out.
Typically, for a director or key employees, the policy is taken out on a 5, 10, 20 or 30-year plan. Commonly for more senior positions, it runs up until retirement age. The shorter the term, the cheaper the premiums. However, it is important to realise that insurance prices increase with age.
Illnesses such as heart disease, diabetes, mental health and more common illnesses may affect the price of the policy too. To save money on your key man insurance, it is better to get it when you’re younger. In addition to this, lifestyle factors such as not smoking, exercise and eating healthily can help to save on costs.
For more information about key man insurance, contact us today. One of our qualified advisors will be able to help see if it is right for you and your business.