Keyman insurance

The loss of certain ‘key people’ in any business can have significant adverse financial effects on that business. Keyman insurance is designed to compensate for the loss of revenue or profitability resulting from a key person’s departure due to death, terminal illness, or total disability.

In addition to Keyman Insurance, businesses may also want to consider Business Expense Insurance to further safeguard their operations during times of uncertainty. Learn more about Business Expense Insurance here.

How Keyman Insurance Can Protect Your Business from the Loss of a Key Person

A business may hold substantial value in property, equipment, and inventory. However, the most valuable assets for most businesses are the people whose talents and efforts fuel its success. These individuals contribute the ideas, skills, and expertise that drive the profits essential for the business’s survival and growth.

Key persons are not limited to Principals or stakeholders. They may also include:
• managing directors
• financial controllers
• computer programmers
• specialist engineers
• expert employees

The sudden loss of a key person brings inevitable costs, some of which may not be obvious. Furthermore, in addition to reduced sales or profits while waiting for a suitable replacement, there are expenses related to recruitment, training, and the time needed for familiarisation. As a result, the business is also likely to experience a negative impact on its capital value, goodwill, and credit rating

Key person insurance helps mitigate some of these unexpected setbacks.

Income protection can also play a vital role in supporting business owners and employees during this time. Find out more about Income Protection here.

Benefits of Keyman Insurance

Key person insurance offers several benefits for a business, including:

• Providing funds to cover outstanding debts and maintain the business’s credit rating.
• Offering extra income in the event of a key person’s death or incapacity.
• Helping to stabilise the business if a key person becomes incapacitated or passes away.

How it Works

Key person insurance serves two primary purposes: a ‘revenue purpose’ or a ‘capital purpose.’ While it may be difficult to separate the two in practical terms, it’s important to differentiate them for taxation purposes.

Revenue purpose key person insurance is designed to:

• Cover the loss of income due to the death, total and permanent disability, or trauma of a key person.
• Compensate the business owners for the profit loss they would incur as a result of the key person’s absence and the impact on the business’s operations.

Capital purpose key person insurance is designed to replace capital losses the business incurs due to the death, total and permanent disability, or trauma of a key person. It can be used to repay all or part of the business’s debt to:

• Secured creditors (e.g., banks)
• Equity participants
• Discharge security held over a guarantor’s property

Calculating the Right Amount of Key Person Insurance

Common methods for valuing a key person for revenue purposes

• Salary multiple
• Replacement cost
• Net revenue multiple
• Combination

Case Study

Business overview:

Tom and Ben run a successful electrical contracting business, specializing in both residential and commercial electrical installations and maintenance. Their business generates $2.5 million in annual revenue, and they’ve built a strong reputation in their local area.

Tom is the lead electrician, responsible for overseeing all high-level technical work, while Ben manages the day-to-day operations, scheduling, and customer relations.

They recently secured a large project to wire a new apartment complex, valued at $1.2 million over the next year. Tom’s expertise in complex electrical systems is crucial to the success of this project, and he’s the key person responsible for ensuring everything runs smoothly.

The Crisis:

• Just four weeks after securing the apartment complex contract, Tom tragically dies in a motorbike accident.
• Without Tom’s expertise, Ben is now left to pick up the pieces. The business is heavily reliant on Tom’s skills, especially for high-level electrical work, and Ben is now struggling to find someone with the same level of experience.
• Ben needs to quickly hire a qualified electrician to ensure the apartment complex project stays on track. If he fails to meet the deadlines, he risks losing the contract and could face penalties of up to $200,000 for delays.
• Replacing Tom isn’t an easy task. Finding a qualified electrician who can step into Tom’s role and manage the project will take time, and Ben doesn’t have the luxury of a lengthy hiring process. This could put the business in a financially vulnerable position.
• Additionally, there’s a risk that the client could lose confidence in the business, potentially damaging the business’s reputation and ability to secure future projects.

The Solution:

If Tom and Ben had key person insurance in place, the policy would have covered the costs of hiring a qualified replacement and any potential penalties for project delays. This would have allowed Ben to keep the apartment complex project on track, complete it on time, and protect both the business’s reputation and future growth