Key Person Insurance: Could your business survive losing one if its key people?

Key Person Insurance can help you get back on your feet

Key Person Insurance can give you the financial support you need while you’re getting back on your feet. It can offset both your costs (e.g. hiring temporary help or recruiting and training a replacement) and your losses (e.g. not being able to do as much business until they finish their training).

It can also help with:

• business succession planning
• protecting your company’s equity value
• agreed funding to purchase the equity
• continuity of equity value for the surviving spouse
• funding re-payments of any capital loans or personal guarantees
• meeting requirements for bank business loans
• salary packaging benefits (depending on the person’s taxation affairs).

And you can take out a policy (which is usually tax-deductible) on anyone you feel is a key person in your company.

How much should I insure them for?

You can set the policy amount to be anything from $500,000 to $10 million. Of course, the amount you specify will depend on the size of your company and the person you’re insuring.

The amount can be calculated in a few ways, including:

• the ‘replacement cost method’, which is based on the cost is to replace the key person
• the ‘contributions to earnings method’, which is based on the percentage of their earnings towards your company’s revenue
• the ‘multiples of income method’, where their current salary is multiplied to determine their value.
  

Protecting your partners (and their partners) with a Buy/Sell agreement

What if the key person happens to be your partner in the company? Yes, the Key Person Insurance may well cover the finances involved in buying your partner’s shares from their family. But do you really want to be negotiating a deal at such an emotionally trying time?

Having a Buy/Sell Agreement in place can save everyone from a lot of anguish. It’s a legally binding agreement that determines what will happen to each stakeholder’s shares if they suffer a major illness or injury, or pass away.

It has two parts:



• The Disposal Mechanism (also known as a Business Will), which states what happens if a partner leaves the business due to death or disability. It usually contains a valuation method.
• The Funding Mechanism, which funds the Buy/Sell Agreement. This is where you would find the details of the Key Person Insurance policy taken out for each partner.

How do I arrange Key Person Insurance?

Before you take out Key Person Insurance you should first speak with your business advisor about the overall approach and then get into the details with an insurance broker. You need to make sure you get the cover you need without paying for the cover you don’t need. We can guide you in this area.

After all, it may well be the key to your company’s survival.