What Is Key Man Insurance?
If you business has grown from a small number of employees having specialist a skill
set and understanding of your businesses position and fundamental to the running of the business. Whether this be financial, technical, sales & marketing these skills may not be transferrable to other individuals in a timely maner, and therefore leaves the business dependent on one or two key individuals to ensure correct operation, maintaining cash-flow and keeping a steady growth within the business.When assessing your business to see if you have any key individuals, it is important to think how long it would take the business to recover to normal operation if the particular key man was removed from your day-to-day operations? Are the profits of the business specifically linked to the key individual? Is there significant cash-flow to maintain the profits during the period of handover if the key person died or took a serious illness such as cancer? What would the cost of training a replacement be? These are all important questions you should be able to answer for your business to ensure the risk to the business has been managed.
How key man insurance works
Key man insurance can be used to mitigate the risk to the business of losing a key person within the firm. providing a lum sum amount to cash-flow and ensure any contracts continue as normal and provide funds to recrutia nd train a replacement. If your key person has taken ill with a serious illness such as heart attack, stroke or cancer the funds can be used to recruit and train a temporary replacement whilst still offering your key man a salary whilst they take a timely recovery. Teh benfit to the business is one advantage but think of how beneficial this would seem to the key employee and their family, especially concidering the circumstances of a serious illness.
Lets take a look at an example. Mr Jones works as an Electrical Engineer for ABC Alarm Systems he is responsible for the design of new alarm systems and is currently heavily involved on a new high profile project which has buy-in from an number of customers already. Looking at two examples, one where ABC Alarms Systems have no key man insurance in place and one where they do: -
ABC Alarm Systems takes out a policy on Mr Jones' life:
Mr Jones dies -> Policy proceeds paid directly to AAS -> AAS have funds to maintain profits -> AAS have funds to find and train a replacement
ABC Alarm systems have no cover:
Mr Jones dies -> Emergency cover needed -> Loss of customers/reputation in the market/No confidence from creditors
It would be a good idea for ABC Alarm Systems to contact their local tax inspector. This will help them to understand tax relief on the policy premiums and the tax liability on any payments made in the event of a claim.
normally, the benefit paid to ABC Alarm Systems is treated as a trading receipt. This means it would be subject to corporation tax at the company's rate for that financial year. It would therefore, make sense if the sum assured was based on gross profits so any tax liability at point of claim will be accounted for.
How much cover is needed?
Depending on a number of factors, including those of which you have concidered already above: -
- Key persons salary
- Total payroll for the business
- Gross profit of the business
- Recovery period (time to return to normal operation)
The following calculation will provide a guide to how much cover would be required for a key individual in your business: -
Sum assured = (Key Persons Salary / Total Payroll) * Gross Profit * Recovery Period
For example if the key person had a salary of 35,000 and the total payroll was £250,000 with a gross profit of £350,000 and time period of 36 months.
Sum assured = (35000/250000)*350000*3 Sum assured = 147,000
To summarize
This is an insurance product which can protect your business from the risk of loosing your key individuals who are fundamental to your businesses profits. The lump sum amount received from a policy payout can ease cash-flow and provide the funds to recruit and train a replacement.
Copyright (c) 2010 Steve Wentworth
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