Term Life & Keyman

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Keyman insurance or key person insurance is a type of insurance that enables the protection of businesses from facing extreme losses due to the eventuality; or permanent disablement of an individual; who plays a critical role in the company. Many of the small and medium-sized companies typically depend on a small, competent, and passionate team and the death of an individual; could lead to disruption in business operations.  So, what is the importance of a Keyman insurance cover?

The importance of Keyman insurance cover can be for transferring the ownership to the successor or diluting the ownership of a company to raise funds for business expansion.

Some important aspects of keyman insurance cover:

  1. Keyman insurance cover individuals who contribute significantly to the revenue of the company.
  2. The beneficiary in the keyman insurance is the company or business entity and not any other individual.
  3. These types of insurance can either be for a specific term or permanent life; based on the nature of the business and the preference of the company executives/decision-makers.
  4. Keyman insurance may also include disability insurance.

Eligibility for keyman insurance cover:

The most important criteria for a keyman insurance plan is that the key person should hold less than 51% of business ownership. The total shares held by the key person’s family should be lower than 70% of the total shares in the business. As part of the documentation; there is a need for proof of high contribution by the key person towards the profitability or revenue of the company.

Thus, a keyman insurance cover is provided for those individuals who are key to the success of the company. They are the primary reason for profitability. Companies or businesses may draw keyman insurance on:

  • Partners or owners of the business
  • Executive leadership team
  • Key sales personnel

Importance of keyman insurance cover:

  • Keyman insurance is essentially a risk management tool.
  • Under the plan, the disability or eventuality of a key person will lead to coverage amount payout.
  • Funds paid out can be used to meet working capital costs, pay off debt and recruit equally talented personnel as replacements.

Sum assured for keyman insurance cover:

The keyman insurance is extended to those companies that have a growth in revenue and profitability; unless there is an exceptional circumstance that is justifiable. The type of loss that any company will incur on the death of the keyman in the company are:

  • Reduced profit of the company due to the loss of the key personnel.
  • The cost incurred by the company to replace the key person.

However, these factors are too abstract to be quantified. Hence, the insurance companies offer a limitation on the maximum sum assured in the form of a minimum of the following conditions:

  • 10x the keyman’s annual compensation package,
  • 3x the average profit generated by the company over the past 3 years or
  • 5x the average profits of the company over the past 5 years

Assessment of keyman insurance requirement

So, the factors based on which the business can ascertain the amount of keyman insurance requirement include:

  • Size of the business and turnover/profitability generated by the business
  • Number of employees and their criticality to the business
  • Training and hiring cost of employees
  • Leverage of the business on the balance sheet
  • Probability of business winds down after the passing of the key person

Risks involved in keyman insurance cover:

The key risk in availing keyman insurance for a person critical to the business, then there is the chance that the person could quit the company to join another. There are a few options that the business has regarding the keyman insurance. The company can evaluate the best option and choose the one that fits well based on the scenario and requirement.

  1. The employer can stop premium payments and allow the policy to lapse. As per the new mandate, only term insurance can be issued as keyman insurance, hence there is no question of losing out on accrued benefits. Until recently, IRDAI allowed the issuance of endowment plans as well under the keyman insurance policies. The recent mandate allows only term insurance and prohibits any loan against keyman insurance and does not allow any riders in the policy.
  2. The employer may enter an agreement with the new company employing the key man and transfer the insurance policy to the new employer on mutually agreed terms. The keyman insurance can be converted to individual term insurance and can be assigned in favor of the keyman who is quitting the company. This will allow the key personnel to continue to pay the premiums and derive the payout benefits by the end of the term.

Keep in mind:

Although not exactly a risk, one should be aware that in the event of an eventuality of the key personnel; the beneficiary (i.e. the company/business receives the entire sum assured as a death benefit. This amount is taxable as business income in the hands of the beneficiary if such beneficiary is the company. If the keyman insurance has been assigned to the keyman, then the key personnel can nominate a beneficiary. The payout in the event of eventuality will happen to the nominee, in such case the death benefit will be tax-free in the hands of the recipient.

Advantages of keyman insurance to the business/employer

  1. Boosts the morale of the employee: Being recognized as a critical resource in an organization increases the employee’s self-esteem, and involvement with the business is more likely. The productivity levels are likely to increase significantly and this could potentially translate to revenue/profitability in the future.
  2. Hedge against business loss: Keyman insurance provides a cushion to the company on losing an employee who contributes significantly to the profits of the company. It is particularly vital for a company/business that operates with a very small, competent, committed team. The loss of any single member can be detrimental to the continuance of the business itself. Keyman insurance ensures that the business has enough funds to continue to run the business and bring in a replacement who will be able to run the business with the required competence.
  3. Tax benefit on premium paid:

    The premium paid towards keyman insurance is a business expense and can be reduced from the overall income. The tax liability comes down to the extent of the premium.

  4. Helps avoid abrupt disruption:

    Losing a keyman can be detrimental in many ways, one such way is when there is a disruption in the credit lines which will impact the day-to-day operations of the business. The insurance money will provide the required funds to keep the business up and running; while the rest of the management personnel make necessary amends to renew the business to its earlier form.

Keyman insurance can be a lifesaver for small and medium-sized businesses which run with a very small and close-knit team. The business/company has to evaluate the key members, ascertain their impact on the business revenue/profitability, and avail keyman insurance on the most competitive terms. SecureNow offers a comprehensive analysis of the range of insurance plans available; this would help you avail of the plan which offers the best terms and conditions and the lowest premium.

 

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