Keyman insurance can keep an SME afloat even if the promoter dies

Published in Economic Times on 3 June, 2015, Written by Kapil Mehta

What is a Keyman insurance?

It is with a little annoyance that I use the word Keyman because it assumes that the important person in a company is a man. That is often not the case and Keyperson would have been a better phrase for the product. In any event, keyman insurance is a pure term plan bought by a company to cover the life of an important employee.

Were the key employee to die the sum assured is paid to the company. The amount of sum assured is generally large and sufficient for the company to hire another senior executive and tide over the likely business downturn. If the insured person survives the term of the insurance then no money is paid to the company.

This kind of a pure risk cover forms a small part of total life insurance sales. That is because premiums are low and distributors not really incentivized to sell this. However, from a risk management perspective this is one of the most sophisticated and good insurances to procure.

What are the benefits of an SME buying keyman insurance?

SMEs are particularly vulnerable to the death of a key person. If the promoter dies then the business is thrown into disarray and often not able to survive. Years of hard work can be washed away and the key person’s family gets no financial benefit from the business. Investors who fund start-ups based on the strength of the founding team are also vulnerable.

These start-ups depend completely on the charisma and skills of their founders. If the founder were to die the investor’s entire funding is at stake. This is why keyman insurance is so critical in start-ups and SMEs. An additional benefit of the keyman insurance structure is that premiums are paid for by the company and therefore reduce tax.

What features of keyman are most relevant for SMEs?

Deciding the sum assured is the most important aspect of a keyman. It is important to remember that the sum assured is linked to the profits of the company and not the salary of the key person.

If the situation is one where a fund has made an investment then the sum assured can be equivalent to the investment made. Another factor to consider in setting the sum assured is that the benefit paid to the company is treated as income subject to tax. This is why it is always better to maintain a higher sum assured.

How does one buy keyman cover?

The company will have to provide a comprehensive set of documents and proposal form to the insurer. The documents generally include audited financial statements of the company, PAN card and a Board Resolution to the effect that the company has decided to procure a keyman insurance. For a key person age 45, a Rs 10 crore insurance cover will cost less than Rs 2 lakhs a year. This is a small cost to mitigate the possibility of an important Person dying.

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