What is Key Person Insurance?
Key person insurance is taken out by a business to compensate that business for financial losses that would arise from the death or extended incapacity of an important member of the business. The insurance payout is a lump sum and is used to offset the costs (such as recruiting a successor) and losses (such as a decreased ability to transact business) which the business is likely to suffer in the event of the loss of a key person.
The most valuable resource of any business is its staff. Loss of key staff can affect every aspect of a business – revenue, profit, goodwill and ultimately the value of your business.
This means that most small to medium businesses are carrying significant financial risk should the unexpected happen to one of their key people. The big question you have to ask yourself is:
‘Would your business be able to maintain its revenues and profits if one of its key people died or couldn’t work for an extended period due to a serious illness or accident?’
If your answer to this question is no, you need to consider transferring that financial risk to an insurance company.
Your financial adviser can help you do that, as well as answer any questions you have about key person insurance, and then calculate how much key person insurance you need to safeguard your business in the event something should happen to one of your key people. And, if you wish, your adviser will use our sophisticated computer program to ‘broker’ the major insurers to find you the right cover at a competitive price.*
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 sales person, key project manager, or someone with specific skills or knowledge which is especially valuable to the company.
Types of insurance
There are three types of risks that can be covered by key person insurance:
- the death of a key person (life insurance)
- their total and permanent disablement (TPD insurance)
- them suffering a trauma such as heart attack, stroke, cancer, and paraplegia (trauma insurance).
There are two categories of loss for which key person insurance can provide compensation:
- A revenue purpose: this protects the business against lost revenue and increased costs in the event of the loss of a person who makes a significant contribution towards the profitability of the business.
Examples of revenue purposes include:
- Recruiting costs
- Training costs
- Fall in sales or profits
- Bad debts.
- A capital purpose: this protects the business through the provision of capital in the event of the loss of a person who make a significant contribution towards the capital value of the business.
Examples of capital purposes include:
- Pay off business loans
- Protect credit rating
- Offset loss of goodwill
- Protect against loss of a major supplier.
It is important the business documents the purpose of their key person insurance (i.e. revenue or capital purpose) to ensure that the taxation treatment of the premiums and end benefits is not compromised.
If you take out key person insurance for a revenue purpose, your insurance premiums are usually tax deductible. However, the insurance proceeds are typically taxable.
If you take out key person insurance for a capital purpose your insurance premiums are not tax deductible. The proceeds of the insurance policy may be taxable.
*Insurance cover is subject to enligibility criteria.
Ownership of the policy
Key person insurance is often owned by the business, as the business is generally the entity that will require the proceeds of the policy.
How much cover does your business need?
Calculating the amount of key person insurance needed for a business requires consideration of: the remuneration of each key person; the cost of recruiting a replacement; the business debts; the business value; the likely impact on the capital value if the key person was lost; and their effect on the revenue and profitability of the business.
Case study 1 – Protecting for loss of revenue
Colin owned a successful and growing small business. Colin’s strength was his ability to win big contracts. Colin recognised that he wasn’t a strong business manager, so he employed June as a professional manager. June dealt with the employment arrangements of staff, office renovations, marketing and client billing, and helped reduce the business expenses and increase the profit. Colin saw that
June was a key person to his business, so the business took out life and trauma insurance on her. When June was diagnosed with terminal cancer two years after she joined the firm, her insurance policy was effected, and the business received the insurance payout. This helped Colin’s business maintain its profitability until he could find a replacement for June.
Case study 2 – Protecting business debts
Franca’s business needed to buy premises to cater for its growth. Franca obtained a business loan to purchase a suitable property. Franca backed the loan with a personal guarantee, a mortgage over the unit and her home.
Franca realised that should she become critically ill she would need to sell the property, the business or the family home in order to repay the loan. Franca took out key person insurance for the capital purpose of paying off the loan. Three years after taking out the insurance Franca suffered a serious illness. The insurance paid out the loan, leaving the business and Franca debt free.
Who is Australian Unity Personal Financial Services?
We specialise in providing professional strategic advice to help you improve your current financial position and ultimately achieve your long term lifestyle goals.
Importantly, our initial advice isn’t a ‘set and forget’ service. Instead we offer you regular financial mentoring and ongoing guidance – in all aspects of your personal finances – to set you, and keep you, on the path to financial wellbeing.
Our team of experienced financial professionals can provide you with a detailed and totally tailored blueprint for financial success in any or all of the following areas:
- Financial advice
- Wealth creation
- Retirement planning
- Home loans
- Commercial loans
- Investment loans
- Equipment finance
- Car finance
- Personal estate planning
- Business estate planning
- Personal risk insurance
- Business risk insurance.
Australian Unity has a proud 170 year heritage of helping Australians create secure financial futures. This pedigree and experience, combined with our corporate strength and leading edge strategic advice capability, means we are uniquely placed to offer you high quality personal financial services… each finely tuned to your particular needs to ensure you achieve your vision of a secure financial future.
After all, your financial wellbeing is at the heart of everything we do.
Any advice in this document is general advice only and does not take into account the objectives, financial situation or needs of any particular person. You should obtain financial advice relevant to your circumstances before making investment decisions. Where a particular financial product is mentioned you should consider the Product Disclosure Statement before making any decisions in relation to the product. Whilst every care has been taken in the preparation of this information, Australian Unity Personal Financial Services Ltd does not guarantee the accuracy or completeness of the information. Australian Unity Personal Financial Services Ltd does not guarantee any particular outcome or future performance. Australian Unity Personal Financial Services Ltd is not a registered tax agent. If you intend to rely on any tax advice in this document you should seek advice from a registered tax agent. Australian Unity Personal Financial Services Ltd ABN 26 098 725 145, AFSL & Australian Credit Licence No. 234459, 114 Albert Road, South Melbourne, VIC 3205. This document produced in November 2013. © Copyright 2013.